Deals with undesirability of debt as a part of corporate capital structure and the consequences with DLF Limted of India as a case study

1. Leverage as a Financial Perversion
-with a reference to Bhushan Steel
-B.V.Raghunandan
Department of Commerce,
St.Aloysius College,
Mangalore
September 18, 2014

2. Leverage
• Leverage: Having debt in the
capital structure of a
company
• In 1950s and 60s, it was
considered to be a magical
act through comparison of
leveraged company and a
non-leveraged company
• Effect was considered for
profitable companies and
non-profitable companies
were ignored

3. Rationale for Acceptance
• High corporate taxes caused reduced tax incidence as interest
on debt was a business expense
• Promoters’ Control was not diluted as debt did not carry
voting rights
• Equity form of finance like venture capital emerged later
• The concept of risk management also emerged later

4. Reality Check
• During a long gestation period of heavy industries and
infrastructure projects, it becomes toxic
• For the industry having a huge capital cost and huge running
expenses like civil aviation, it is devastating
• When unexpected risks exist, the tables will turn very quickly
• Prolonged trade cycles like mining and metal industries

5. Warning
• Sharia held debt to be a sin
• Shakespeare maintained, "never a lender nor a borrower be”
and also depicted the cruelest aspect through the character
of Shylock in Merchant of Venice
• Financial Management considered both equity and debt to be
the components of capital structure
• Never considered the repayment programme, cautions,
warning signals etc as an important exercise

6. A Carefree World
• Corporates did not learn the lesson
leading to the development of art
and science of bankruptcy
• Individuals and families were
encouraged to overborrow like
housing finance, consumer finance,
finance for hospital bills, student
loans
• Questionable methods employed for
recovery including foreclosure
• Credit card booms
• Empty houses and homeless
population

7. Revival of Equity Culture
• A more mature and developed primary market and stock market
• Reduced corporate tax rates
• Emergence of venture capital and private equity fund
• Contribution of HNI and Angel Investors
• A Systematic Risk Management and Popularity of debt-free capital structure
• Basel Norms for Banks

8. Rationale for Equity Shares
• No need to pay dividend in the absence
of profit
• Even in the presence of profit, a growth
oriented company does not declare
dividend
• No need to pay dividend during
gestation period
• Large body of investors to share the
losses
• Equity shares are the cheapest source
of finance
• Shareholder Loyalty for other projects
and group companies
• Huge funds can be raised through IPOs
and FPOs
• Share Premium as another cheap
source of finance
• Listed companies having access to
cheaper foreign funds

9. The Fallen Empire-DLF Limited
• 1946-Chaudhry Ragvendra
Singh promoted
• Developer of residential
and other complexes in
Delhi until 1957
• 1957-Delhi Development
Authority banned private
developers
• It went out to Gurgaon in
Haryana to develop a city

10. IPO Details of DLF Ltd.
• 2007-IPO made
• 17.5 crore shares of Rs.2 through book-building
• Cut-off Price Rs.525
• Face Value of Shares: Rs.35 crore
• Share Premium: Rs.9,152.5 crore
• Share Price went upto Rs.1000 in 2008

11. Falling Down from Grace
• Forays into Capital
Intensive expansion
• Hospitality Industry
• Wind and other power
business
• Extensive Borrowings
• Debt: Rs.19000 crores
• Questionable Trade
Practices

12. Correlation between Interest and Profit of DLF Ltd.(Figures in
Rs.Crore)
Year Sales Interest Profit
2007-08 14433 310 7,847
2008-09 10,035 555 4,497
2009-10 7,423 1,110 1,709
2010-11 9,560 1,706 1,638
2011-12 9,629 2,246 1,169
2012-13 7,773 2,314 663
2013-14 8,298 2,463 582

13. Alternative
• FPO at the cut-off price of IPO could have
brought in a huge amount of cost-free funds
• It would have saved the interest
• More meaningful diversification
• Taking care of quality of building in Gurgaon
and maintaining the customer relation

14. THANK YOU